eLearning

David A. Starrett

Economists are widely viewed by the general public
as being committed tomarkets as a way of allocating
resources and consequently to the use of market
prices as a reflection of social value. This view has
given economists a bad reputation in some circles;
indeed, there is a cynical definition of an economist
as someone who ‘‘knows the price of everything and
the value of nothing.’’ Whereas economists prob-
ably do as a group have more faith in markets than
others, it certainly is not true that we equate price
with value. We recognize many goods and services
for which there are no markets (such as clean air,
wildlife habitat, and fishing stocks) as having value.
Furthermore, for some market-traded goods, we
recognize that price is not a good measure of value
due to the presence of externalities; for example,
with electricity produced from the burning of coal
that generates air pollution the price of electricity
does not reflect the social cost imposed through
pollution.
However, even when market price is inadequate,
we find it useful to work with a ‘‘price-like’’ concept
in dealing with allocation problems. This is partly
because good decision making requires a means of
measuring the value of market and nonmarket
goods in commensurate units. For example, in
deciding whether or not to allow an additional
coal-fired plant, we need to measure the cost of
pollution in units comparable to themarket value of
energy.We refer to the cost per unit of pollution as a
‘‘shadow price.’’
The determination of shadow prices is an inexact
science on which there is an extensive literature.
Because many of the ways of determining these
values are discussed elsewhere in this volume, I will
confine my remarks to a few generalities and one
important example. In a democratic society, values
used in public decision making should reflect values
held by individual citizens. Formanymarket-traded
goods, we can argue that market prices are the right
measures because individuals trade off at the mar-
gin amounts of apples and oranges, for example, to
purchase based on their relative expense (price).
However, for goods not traded on markets (such as
clean air), other methods must be devised for
determining consumer willingness to pay for them
in terms of market goods. The resulting weights are
referred to as shadow prices because they play the
same role in allocation as do market prices for
traded goods.
When there are no markets on which people can
directly exercise their preferences, shadow pricing is
more difficult, and there are pitfalls. We can try, to
ask people how they would value a hypothetical
change in biological diversity, for example, but if
such people are not well informed about possible
consequences, theymay not give good answers, and
even if well informed, research has found that
people are not very good at thinking about hypo-
thetical situations—in particular, the answers they
give vary widely as a function of how the questions
are asked. Economists are more comfortable if
preferences can be inferred from decisions actually
taken (as is the case formarket goods). For example,
we can infer something about the value placed on
clean air by looking at the differences in land rents
on clean versus dirty sites. Unfortunately, however,
these methods too are rather imprecise. Our posi-
tion is, however, that having some estimates is
better than having none, and even ballpark esti-
mates can help inmaking informed decisions. Econo-
mists are constantly working to improve the neces-
sary methodology